Code Red: Two Economists Examine the U.S. Healthcare System

October 19, 2011

Lessons from the Class Act

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 8:39 am

Last week, the Obama Administration decided not to implement the Community Living Assistance Services and Supports (CLASS) Act. This Act authorized the Department of Health and Human Services (DHHS) to sell a low price/limited benefit long term care insurance (LTCI) plan, provided that the plan would be actuarially sound. The Act also required DHHS to perform a 75 year financial projection. After a year of analysis, DHHS concluded that there was the plan could not cover its costs and so it pulled the plug on CLASS.

I first learned about CLASS when I was asked by a senior economist in DHHS to provide a strategic assessment of the business prospects for CLASS. DHHS officials were appropriately concerned that the low price/limited benefit plan would almost surely suffer from adverse selection and end up losing money. So they wanted to know whether CLASS could offer additional LTCI plans to cover the losses in the base plan. I persuaded Cory Capps (a former colleague and partner with BatesWhite, an economic consultancy) and Leemore Dafny (my current colleague at Northwestern) to help with the analysis. We shared ideas with economists working within DHHS.

We viewed this as a traditional market analysis. Anyone can enter a market and lose money – the base CLASS plan would be a poster child for this obvious point. We wanted to understand whether there were any opportunities to turn a profit in the LTCI market. We also wanted to understand why, if there are profits to be had, private insurers had not already exploited these opportunities?

What we found was a rather strange market. There are lots of LTCI sellers, mostly crossovers from the life insurance market. This makes sense, because the main purpose of LTCI is to help enrollees preserve their retirement savings. The same customer who buys life insurance to make sure their next of kin are well taken care of would therefore also want to buy LTCI. These customers trust life insurers, most of whom have been around for a century or longer and can be counted on to pay out future benefits. At the same time, LTCI products are remarkably (perhaps unnecessarily, and likely strategically) complex, so customers rely on their insurance brokers to explain their options. These features helped mute competition among LTCI insurers and possibly pose entry barriers to new sellers.

We were reasonably convinced that CLASS could rely on the reputation of the federal government to assure future payouts. (We would have been more convinced a few years ago.) And the CLASS Act provided DHHS with a chance to work around the broker market – employers would be given the option to offer CLASS LTCI to their employees, although it was not clear if employers would be eager to participate. So it seemed that DHHS could overcome the two main barriers to entry.

With the wind in our sails, we addressed the most critical questions: What products would DHHS sell? How would it penetrate the market? Could these products survive competitive forces? We immediately rejected the idea of offering the same products sold by private LTCI firms. If DHHS sold the same products that were already on the market, private insurers would surely match on price and the market would have to expand to accommodate CLASS insurance. This was a risky prospect, as private insurers had been trying to grow the market for years with very limited success.

Putting on our strategy hats, we wondered if DHHS could come up with new product features, thereby attracting a broader base of enrollees. Exchanging ideas with DHHS economists, we came up with quite a few suggestions: tontines (where enrollees enjoy rebates of premiums if they don’t end up needing LTC), extended vesting periods before coverage began, “short term” LTCI and others. We laid out the advantages and disadvantages of each feature and we asked a critical strategy question: If these features are so promising, why aren’t private LTCI insurers offering them? For some features, such as the extended vesting period and the tontine, we were reasonably sure that DHHS could secure a profitable niche in the market. Even so, we wondered how these ideas would be explained to consumers. LTCI insurers relied on brokers. Who would get the word out for CLASS?

On balance, we were rather optimistic about the potential success of some of the “new” LTCI features that could be offered through CLASS. Many uncertainties remained, however, and we were unable to project the profits that these products would bring in. This came with the territory; we were essentially viewing DHHS as an entrepreneur bringing new products to the market, and entrepreneurship is fraught with uncertainty. When it came time for DHHS to perform the mandated 75 year projection of CLASS profitability, the unpredictable profits from the new products could not offset the certain losses from the base plan.

In retrospect, perhaps this was the best outcome. I could imagine DHHS succeeding as an entrepreneur in the LTCI market, but I would have misgivings. The federal government as business entrepreneur – it almost makes me shiver. Even so, I came away from this experience feeling a little more optimistic about our government. Editorials in the Wall Street Journal and elsewhere applauded the demise of CLASS, arguing that the act was politically motivated and made little economic sense. I will not comment on the political motivations, but I will say that when it came to our contribution to this matter, DHHS officials remained focused on the economic realities.

1 Comment

  1. Comments on the article: “Lessons from the Class Act”:

    I read your study with much interest, due to my background working for private insurers in the long-term care insurance industry. Early on, when I first became aware of the CLASS Act, I, too, saw that it could not live up to expectations. I didn’t undertake a rigorous market analysis, but rather relied upon my experience serving employer-based plans large and small, private sector and public, in many different industries. I’ll share comments below as I follow-along the points in your research paper.

    Though adverse selection ultimately may have contributed heavily to the early demise of the plan, I never underestimated the potential impact of the absurdly low benefit levels. As I recall, the daily benefit option for facility care topped out at $75. That is sufficiently lower than reality today, in most of the larger metropolitan areas of the country. And the program’s required 5-year waiting period before benefits could be claimed against the policy would have been a hardship for many insured members. In other words, a $75 reimbursement for facility care that takes effect at least 5 years out likely would offer little help for a nursing home resident facing well over a $200 daily facility charge–today.

    There has been steady, but slow and not spectacular growth in the employer-based LTCI market. The negatives that stand in the way of purchase are several. Many employers offer LTCI as a totally voluntary plan, meaning the eligible employee and their extended family pays all the premium. There are some exceptions where employers contribute some funding for a “base” or “core” plan, but it’s not prevalent, and when in place, not of any serious consequence. Offering LTCI is a vehicle that allows employers to tell their population we, the employer, are aware of your needs and want to add to your “total compensation package.” Employers have little skin in the game, despite those who take payroll deductions for the premiums (many do not, and request that the insurance company direct bill the members). Often, LTCI is a benefit that is treated as an orphan to the more significant medical, dental, 401(k), and other highly visible fringe benefit choices the employer gets mileage from promoting.

    Many people think the product is “complex,” as you noted, but it need not be with appropriate communications and outreach. Because I personally researched and drafted legally-enforceable contracts and understood the underlying laws and regulations comprising the plans’ structure and purpose, I relished the opportunities in my work to make these benefits simple, straightforward, and valuable – i.e., worthy of thoughtful consideration before making a judgment.

    When you compare LTCI to the more involved products like annuities (including all the many variations of them), universal life insurance and other permanent life coverage (again, all the varieties and options), and revocable living trusts….well, LTCI is one topic that an individual can quickly master. Insurance mitigates a certain type of named risk, in return for a specific charge (premium), that would otherwise be assumed by the insured person. LTCI – on its highest level – meets this definition and by so doing, shares many similarities with other more prevalent insurance benefits.

    The CLASS benefit levels are way too modest, and the usual employer stance means signing a master application for LTCI as an adjunct to, but never fully integrated with, the firm’s other employee benefit plans. Aside from the above, there are other factors that would have doomed CLASS, just as they are impeding growth in the private sector.
    Premiums for LTCI are required by current law to be deducted from pay after tax, not pre-tax as enjoyed by dollars spent on medical, dental, 401(k), and some reimbursement accounts. People confuse LTCI with long- and short-term disability products, and ignore the opportunity to enroll in LTCI at a time most advantageous to them (i.e. guarantee issue as a first-time buyer). And as always, there are the cadre of eligible employees who believe, mistakenly, the prospect of needing help with long-term care services as one ages (or suffers an accident) will happen to others, and not to themselves; or that a family member will be there when needed…hence no need to spend disposable income now. It’s still a widely-held belief that someday, somehow, Medicare and/or Medicaid will cover the costs of long-term care needs comprehensively and for a longer period, whatever they may be.

    I have always advocated for LTCI, having purchased the coverage when it first became available to me years ago. And then, once I began serving the market in various roles with my employers, that passion became stronger. With the CLASS Act not being implemented, perhaps those who have been on the fence up until now, waiting to see what benefit varieties they could obtain through this federal program might now realize they are on their own to fill the needs. We’re seeing a confluence of many different events unfold, such as the baby boomers who have experience as caregivers for their parents’ and grandparents’ generations, without having LTCI, even in its early years. That experience of seeing a lifetime’s worth of savings eaten up by a facility, or by family caregivers working in the home – including the physical, emotional, and financial hardships often encountered during the course of treatment — can sober up anybody to the point where they don’t ever want to duplicate the exposure without having the resources to take care of themselves where most appropriate to their condition, nor be a burden to someone else. To me, at least, this suggests the greatest era for the growth of LTCI may lie ahead.

    Too many carriers didn’t price the plans correctly due to faulty assumptions, eagerness to consume market share, and other reasons that tainted the public’s appreciation of the LTCI product and the protection it offers, and continue to do so. Plans already exist with nonforfeiture options that return premium based on formulas, allowing the insured to get something back when terminating their plan, a feature many employees would ask about.

    With new state laws and regulations in effect, such as those adopted from the NAIC LTCI Model Statute, with its requirements on pricing, product standards, and procedural uniformities, we will see positive changes.

    Kellogg taught me well. This valuable and relevant employee benefit has a far better chance to assume the role it justly deserves in one’s future security portfolio. First must come the continuous quest to define need, using marketing techniques that excel in research, planning, interpretation, issue resolution, implementation, and communications – in writing, in-person, via electronic means, and so forth that adapt well to getting the message out there. Long-term good will come to this industry and those it serves through best practices directed toward better identifying and serving needs, encouraging employer buy-in (as that becomes more feasible economically), and educating consumers to face head-on the reality that for a majority of us, as we age, our abilities to perform activities of daily living all by ourselves greatly diminish. Long-term care insurance serves this purpose better than other alternatives that are not uniquely customized for this role.

    Comment by Jeffrey Kollum — November 23, 2011 @ 7:18 pm

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